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Saturday, February 10, 2018

Systematic Withdrawal Plan will be the instrument to fight Long Term Capital Gain Tax

Its been about a week that our finance minister read out the budget to the nation, but I still cant get out of the angst of levying 10% tax on #long term capital gain on equity and mutual funds investments. 

Though the markets have reacted in the expected lines by shading about 500 points on Nifty, I expect it to settle at some point in about few months depending on the course of action decided by the large institutional investors. The sudden shock of introducing #LTCG after 14 years on Equity will be hardest on the small investors, who have been told continuously over the years that equity is the best investment option and investing through #SIP in Mutual Funds is the best option.

What is long term capital gain tax on equity - When an investor buys and keep his equity investment over a year and withdraws, the profit generated on the investment is subject to taxation if it is above Rs. 1 lakh. This is applicable to all investors including individual, HUF, FPI. Mutual Funds have been exempted for this, as this is taxable in the hands of Investors.

Also, Mutual Funds will levy 10% dividend distribution tax on dividend options under various equity schemes.

(Short term tax on equity and equity based mutual funds stand at 15%)

#SWP Calculator
Things were different until 5 days back, when capital gain tax was zero over 1 year, but now we have to learn and adjust to the new normal. What we understand basis the announcement is if we make profit over 1 lakh in a financial year on equity or equity based mutual funds, we have to pay tax on the money over 1 lakh on the long term capital gain (over 1 year). Refering to the chart below on illustration, the tax is applicable to the profit generated over and above 1 lakh. Also, as the budget will only come into effect from April 1, returns above 1 lakh wont be taxed.

Long term capital gain calculation sheet
Investment amount
Entry date
Exit date
Gain = Amount - Investment
Tax applicable
Net Profit
1st Jan 12
1st Mar 18
3 lakh
1st Jan 12
1st Mar 22
10% of 5 lakh
= 50 thousand
5.5 lakh
Equity MF
1st Jan 12
1st Mar 18
2.5 lakh
Equity MF
1st Jan 12
1st Mar 22
10% of 4 lakh = 40,000
4.6 lakh

Incase of #SWP,  profit will be spread per unit basis. Spreading out the withdrawal over a period will be beneficial for tax saving.

What is SWP?

SWP Is a disciplined approach towards investments withdrawal. From a mutual fund scheme investor can chose to withdraw a fixed sum of money or pre-decided number of units of units every month. (This is not dividend scheme). This is nothing but selling investments, booking profit but just in staggered manner.

Recommend highly as post-retirement earning or for people on sabbatical. It also work out well for second income generation. To illustrate the benefits on a table, I have taken a hypothetical investment of Rs. 5 lakh in 2013, in an equity scheme. 

I have made an illustration on SWP for better understanding on the same. The table is drawn with an assumption that the fund value has grown to Rs. 10 lakh. The sum of Rs. 15 thousand to be withdrawn from the period of April 2018 to March 2019. 

In the above case, the investor have to pay any tax on 10% Tax on three thousand eighty three that is Rs. Three hundred and eight only on his withdrawal.  

By no mean I am portraying tgat you can escape LTCG Tax completely by following this method. It can be used as a method if you dont require the money at one go. It can work like a pension and can be withdrawn to be tax efficient. One may also consider having other pension options which are tax efficient in nature. 

The benefits of SIP have been spoken about a lot. It is about time that we start taking a view on SWP as a tool for withdrawal to make most of the mutual funds investments. SWP Mutual Funds reminds us time and again about discipline. It can beautifully work as a pension or work like extended salary in time of need. It is not required to be a market specialist to invest in it. Choose an equity fund and keep investing for the long term.

This is only applicable to open ended equity and equity based hybrid mutual funds.
systematic withdrawal plan, SWP Calculator, 
Keep investing!!  

Tweet me at debashree_ad for any clarification.

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